5/24/2018 www.taxmann.

com

[2018] 93 taxmann.com 354 (Article)

[2018] 93 taxmann.com 354 (Article)

Tackling the Menace of Shell Companies In India: A Study

AMIT BHASKAR
Assistant Professor in Law in Nirma University, Ahmedabad

Introduction

Since the last few decades, the nature, extent and gravity of white collar crimes have increased manifold
and hence it has become a matter of concern for the governments all over the world. The same is true for
India also. The economic crimes such as money laundering, benami transaction, tax evasion, generation
of black money and smuggling not only cause revenue loss and foreign exchange loss to the government
but it also creates economic inequalities in the society. Going further, it also compromises the economic
sovereignty of the state in the long run. In India, a tendency has been observed in the last few years that
most of these illegal activities are committed through incorporation of companies. These companies
neither have assets nor liabilities nor any operational businesses. They exist only on paper to facilitate
illegal financial transactions such as money laundering and tax evasion. These kinds of companies are
called shell companies. Though shell companies per se are not illegal, but if they facilitate any illegal
transactions, they become liable under the law. This is primarily the reason the Ministry of Corporate
Affairs in recent times have tightened the noose around shell companies and have de-registered more
than two Lakh shell companies in the year 2017 which are suspected to be used for money laundering
and tax evasion as a part of its Operation Clean Money drive. In the light of the above background
information, in this paper, I will focus on the nature of shell companies, the modus operandi of these
companies and the efforts made by the government in the recent times to curb their menace.

Shell Companies

Shell Company is not defined in the Companies Act, 2013 nor was it defined in Companies Act, 1956.
However, the term generally refers to those companies which do not have any businesses of its own or
assets of its own but exist only on papers to carry out illegal financial transactions. In the United States
of America, shell company is defined as "a registrant with no or nominal operations and either no or
nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of any amount
of cash and cash equivalents and nominal other assets". These companies do not provide any goods or
services but they pretend that they are providing goods and/or services just to cover up their illegal
activities. These kinds of companies do not file annual returns to the Registrar which gives rise to the
suspicious nature of their activities. The illegal motive for incorporation of such companies may be to
evade tax through bogus transactions, money laundering and for round tripping of black money which
has become the main concern of the regulators all across the globe in the recent years. However, there is
no offence to be a shell company per se. The maximum the Registrar can do is to strike off the name of
such companies from the Register of Companies. But if the shell company is involved in money
laundering or tax evasion or for other illegal purposes, then the relevant provisions of laws under
Prevention of Money Laundering Act, 2002, the Prohibition of Benami Transaction Act, 2016, the
Income Tax Act, 1961 and the Companies Act, 2013 become applicable to these companies.

Need for Tackling the Menace of Shell Companies

about:blank 1/6
5/24/2018 www.taxmann.com

The necessity for curbing shell companies in India stems from the fact that these companies are
incorporated extensively for carrying out illegitimate transactions which aims at money laundering, tax
evasion, generation of black money, carrying out benami transactions, shifting of corporate profit to tax
haven jurisdictions and consequent huge losses in tax revenues. There is also an apprehension by
Financial Action Task Force (FATF)1 that shell companies are used for financing of terrorism. In recent
times, the shell company has become a most favoured mechanism through which white collar crimes are
perpetrated thus endangering the integrity of the financial systems of the country. The Government is of
the view that presence of shell companies in the country lowers the investors' confidence and also
adversely affects the foreign investment as foreign investors would not like to make investment in shell
companies. Though most of the shell companies are incorporated as private companies, still a number of
them are incorporated as public companies and are even listed on stock exchanges. As a result, SEBI has
put those suspicious companies under surveillance. In 2017, the SEBI has taken action against 331 shell
companies on the basis of input provided by Ministry of Corporate Affairs. The share trading in these
companies were restricted. Thus, the menace of shell companies can also infect the stock markets and
trading platforms.

Modus Operandi of Shell Companies

Since there are very few academic literatures available on shell companies, it will be imperative here to
understand as to how these shell companies operate. There are complex web of transactions through
which these shell companies indulges in illegal activities. Some of which can be illustrated here.

Use of Shell Company for Tax Evasion:

There is a Company Called C which wants to commit tax evasion by inflating its figure on expenditure
side. The promoters of this Company incorporated a shell company Called S the object clause of which
says that it specializes in providing consultancy services. The Company C shows to the Tax Authorities in
its tax return that it had invested Rs. 50 Lakh in hiring the Consultancy Service provided by Company S.
There was no real transaction. It remained only on paper. The intention was to reduce tax liability by
showing consultancy service expenditure of Rs. 50 Lakhs which in reality did not take place. This
resulted in revenue loss to the Government.

Use of Shell Company for Remitting Black Money abroad through Inflated Import Bill as
well as Fake Import Bill

A, an Indian resident, along with his associates incorporated a shell company called S in a tax haven
jurisdiction. Let us suppose in Hong Kong. This shell company does not provide any goods or services.
This shell company sent an inflated Import Bill to A in India of certain items purportedly produced by
this company which in reality was not produced by the company but only purchased from somewhere
else pretending it to be its product. Inflated Import Bill means that money a person going to pay for a
particular imported good is much higher than real market value of the same product. A pay a highly
imported bill knowingly and through this, his black money (the difference between the actual price and
inflated price paid) is safely routed to Hong Kong which is a tax haven jurisdiction. Behind this shell
company, as I said, is A and his associates.

In second scenario, A went to his Banker in India with a fake import Bill and forged Bill of Lading
document and invoice. A request his bank to transfer money from his account into the account of a
Company called S ( in reality a shell company), being the supplier of the good, so that Company S release
the imported goods which can reach to the port of destination in India. The Banker trusted his client A
and released the amount of Rs. 5 Crore from A's account into the account of shell company S in Hong
Kong. Through this modus operandi, A managed to send Rs. 5 Crore of Black Money into the tax haven
jurisdiction of Hong Kong without any goods really being imported.

about:blank 2/6
5/24/2018 www.taxmann.com

As per one estimate of Enforcement Directorate, the amount of Rs. 6000 Crore has been illegally
remitted to tax haven jurisdictions through this fake import bill racket in the recent past.

Shell Company as an Instrument for Round Tripping of Black Money

In the last example relating to inflated Import Bill and Fake Import Bill, A's black Money reaches to
offshore tax haven jurisdiction Hong Kong in the account of the shell company incorporated by A and his
associates. Now, through multiple layers of companies in Hong Kong and other tax haven jurisdictions
like Bermuda and Mauritius, the same amount of black money is routed to India under the guise of
Foreign Direct Investment. In reality, the money shown as FDI belongs to A and he successfully managed
to do round tripping of his black money through the instrumentalities of shell companies.

Shell Company as an instrument for Money Laundering

A person named AB was a Minister in the Ministry of Finance. He demanded 45 lakhs as bribery amount
for giving some favorable treatment to a person called X. Now, in order to get the bribe amount through
incorporation of shell company, the son of AB, in collusion with his father, incorporated a company
called S. The company has no assets of its own nor does it have any operational business. There are five
shareholders in the company (all AB's associates). The nominal value of one share is Rs. 100. However,
the bribe giver X purchased the share of the Company S at a whooping rate of Rs. 10,000 per share. He
purchased 500 shares by paying Rs. 50 Lakhs. Later on, the bribe giver sold the same shares to the
existing shareholders of the company S at a price of Rs. 100 per share amounting to Rs. 50,000. Thus the
existing shareholders of (all associates of AB) shell company S got the whooping amount of Rs. 45 Lakh
by purchasing the share of X who ceases to be shareholder. Behind the shell company is bribe taker AB's
son and his associates. The bribe amount has been laundered to project it as untainted money through
the shell company.

Misuse of Shell Company during De-Monetization

A incorporated a shell company called by the name of AB Agro Food Private Limited which is supposedly
into the business of food processing but in reality it is a shell company with no assets, liabilities or
operational business of its own. During the period of demonetization, A, personating himself as a
director of the company, opened a bank account in the name of the company. Then he deposited old
currency note to the tune of Rs. 10 Lakh, showing it as an income of the company, into the account of the
company. Few days later, Rs. 10 Lakh in new currency notes was withdrawn as money required for the
business purpose of the company. Thus, a shell company was used to deposit old currency notes (Black
Money) and withdraw the new currency notes. As a result, black money of Rs. 10 Lakh was converted
into white through the instrumentalities of shell company.

Steps Taken against Shell Companies

To prevent the misuse of separate legal personality in the form of incorporation of shell companies, the
Ministry of Corporate Affairs (MCA) has taken number of steps. First, it has de-registered around 2 Lakh
shell companies by resorting to Section 248 of the Companies Act, 2013 under which the Registrar of the
Companies has the power to strike off the name of the company if it does not comply with certain
conditions2. Secondly, the MCA has resorted to Section 164(2) (a) of the Companies Act, 2013 which
provides for disqualification of directors of those companies which have not filed returns for three
consecutive years. The Directors would be disqualified for a period of five years from holding
directorship in any company. There were similar provisions for disqualification under 1956 Act.
However, earlier the provisions were applicable only to public companies but under the 2013 Act, the law
applies equally to private companies. Most of the shell companies are incorporated as private companies.
Thirdly, the MCA and SEBI have directed the forensic audit of those companies which are suspected to
be of shell companies and are involved in illegal activities. Fourthly, the Government is considering
making it mandatory to quote Aadahar Number for Key Managerial Personnel (KMP) including the
about:blank 3/6
5/24/2018 www.taxmann.com

Directors under the Companies Act, 2013. This will enable the regulator to trace any person who is on the
Board of Directors of number of companies which are having similar traits of not carrying significant
accounting transaction or are defaulters in filing annual returns to the regulator. In addition, there are
many other steps that the Government has taken in recent years.

Task force on Shell Companies

In February, 2017, the Government had constituted "Task force on Shell Companies" under the joint
chairmanship of Revenue Secretary and Secretary, Ministry of Corporate Affairs to monitor action
against shell companies for effectively tackling the wrongdoings by the these companies. The other
members in the Task Force were representatives from Enforcement Directorate (ED), Central Bureau of
Investigation (CBI), Financial Intelligence Unit (FIU), Serious Fraud investigation Office (SFIO),
Department of Financial Services (DFS), Central Board of Direct Tax (CBDT) and Central Board of
Excise and Custom (CBEC). The Task Force took some of the strong decisions against these shell
companies. Some of these are:

♦ SFIO has decided to prepare a comprehensive digital database of all the shell companies that
were identified by the enforcement agencies.
♦ During the financial year from 2013-2014 to 2015-2016, the income tax department have
detected more than 1155 shell companies which were used by over 22,000 beneficiaries.
According to department estimate, the amount involved was more than Rs. 13,300 crore. The
department has filed criminal complaint against 47 persons.
♦ The Ministry of Corporate Affairs has removed 1, 62,618 Companies from the Register of
Companies by resorting to Section 248 of the Companies Act, 2013.
♦ The MCA has also taken initiative of disqualification of directors of these companies as per
Section 164(2) of the Companies Act, 2013.
♦ The Financial Intelligence Unit (India) has been directed to alert Reporting Entities under
Prevention of Money Laundering Act, 2002 for enhanced due diligence.
♦ With a view to streamline and strengthen the information sharing mechanism between
different enforcement authorities, a new Standard Operating Procedure (SOP) has been agreed
under the aegis of Task Force.

Freezing of Accounts of Shell Companies

In addition to the above steps, the Government has requested the Reserve Bank of India (RBI) to direct
the banks to freeze the accounts of defaulting companies which have failed to file annual returns and
financial statements. The Government has also requested the RBI to circulate the details of defaulting
companies to all the banks for the purpose of enhanced due diligence. Thus, a "Whole Government"
approach has been adopted by ensuring better coordination among the government investigative
agencies and regulatory bodies. Recently, the Parliamentary Standing Committee on Finance has
recommended real time data sharing among all the government bodies.

Data Sharing Agreement between Income Tax Department and MCA

Taking further steps, the Income Tax department has decided to share tax information with MCA. The
aim is to identify those shell companies which are allegedly involved in money laundering and tax
evasion. Under this information sharing agreement, the tax department will share Permanent Account
Number, Income Tax Returns and audit report of corporate bodies as well as statement of financial
transaction relating to these companies. The Income Tax Department will also share Corporate
Identification Number and Director Identification Number with the Ministry of Corporate Affairs. This
information will be necessary for identifying shell companies suspected to be of dubious transactions.
For this purpose, a memorandum of Understanding (MOU) will be signed between Income Tax

about:blank 4/6
5/24/2018 www.taxmann.com

Department and MCA which will include mode of transfer of data, preservation of data and maintenance
of confidentiality of information.

Centralized Know Your Customer Registry

The Central Government also plans to have a centralized Know Your Customer (KYC) Registry for
tracking and data mining of companies sharing similar characteristics like common directors, same
residential address, no operational business, no assets and liabilities and other similar traits like
common promoters of these companies. This will enable the agencies to track down the shell companies
and the people behind them and also put these companies on surveillance. The MCA has decided to
undergo extensive data mining exercise in order to trace the ultimate beneficiaries of these companies.
The Government also plans to use data analytics and artificial intelligence in order to collect the
incriminating data against these companies. With the help of artificial intelligence, the Government is
trying to develop a state of the art Early Warning System (EWS) in case any suspicious transactions are
detected in these shell companies.

Legal Definition of Shell Companies

The investigative agencies and market regulator SEBI has proposed to the Government that there should
be a legal definition of shell company as there is no law in India which defines shell company at present.
The definition will give legal clarity so as to enable the investigative agencies to carry out investigation
more swiftly and also to put those suspected companies under surveillance. At present, without any legal
definition, it is difficult for the agencies to monitor and investigate these classes of companies. In a very
recent development, the Parliamentary Standing Committee on Finance has asked the Government to
define shell company under the Companies Act. The Committee has asked Government to ensure
distinction between those companies involved in fraud and those which were merely irregular in filing
returns and financial statements to the Registrar. The Committee was of the view that out of 2.26 Lakh
companies de-registered by the Government, some may not have fraudulent intention and may have only
failed to file return on time. The Committee was of the view that to avoid any legal ambiguity and also
unnecessary litigation and also withstand scrutiny in court of law, the term needs to be defined in the
Companies Act with fraudulent intent as one of the characteristics feature of these companies. The
definition under consideration is those of Organization for Economic Cooperation and Development
(OECD)3. However, the experts are of the opinion that definition must be India centric. The SEBI has
tried to define the term as an entity having no significant operational assets or business activities of its
own but acting in a pass-through capacity as a conduit. The parameters which have been suggested to
define shell companies also include multiple companies having the same residential address, no physical
existence at the given address i.e. no office and/or no employees, high ticket transactions inconsistent
with the business of the firms and rotational transactions with no legitimate business groups. A
comprehensive and unambiguous definition will give more powers to the investigative agencies to take
action against these companies.

Identification of Properties Registered in the Name of Shell Companies

Intensifying its fight against Black Money, the Ministry of Corporate Affairs has asked the States to
identify the properties belonging to around 2 Lakh companies which were de-registered by the MCA on
the ground of suspected nature of transactions. Since these companies have been de-registered, they
cease to be a separate legal personality in the eyes of law. Still there is apprehension that transaction
could take place in these companies assets and properties so as to take the assets out of the clutch of the
enforcement agencies. In order to prevent it, the MCA has asked the States to complete the process of
identification and tracking of these properties as soon as possible so as to prevent the fraudulent
transactions in these properties. The MCA has urged the states to share information with it in a time
bound manner. Since the land records have been computerized, the states government can provide the
requisite information at the earliest. The MCA is of the view that since these companies have been de-

about:blank 5/6
5/24/2018 www.taxmann.com

registered, any transaction pertaining to the properties owned by these companies shall be null and void
till the time the separate legal personality of these companies is restored by the National Company Law
Tribunal. Once the name has been struck off, the legal ownership of properties belonging to such
companies has become non-existent. The Central Government has asked the States to urgently issue
direction to the district authorities to prevent transaction in properties belonging to de-registered
companies by adopting an appropriate mechanism. The Government has said that such steps of tackling
shell companies is a significant step in fight against black money and unearthing of benami properties.

Plan for Further De-Registration of Shell Companies

In addition to 2.26 Lakh Companies which has been de-registered in an effort to crack down on shell
companies last year, the Government is again intensifying its effort to crack down on these companies.
The government has identified around 2.25 Lakh companies this year and has sent notice to them under
Section 248 of the Companies Act, 2013 asking them whether they had filed statutory returns.
Depending upon the reply received, the government will intensify its crackdown against these
companies. Thus, the effort of the government in this direction is continuous in nature.

Concluding Remarks

As discussed in this paper, the shell companies, in recent times, have become potential instrument for
perpetuation of serious economic crimes in the country such as tax evasion, money laundering, benami
transaction, conversion of black money into white and host of other offences. The presence of shell
companies and its potential use for illegal activities threatens the economic integrity and sovereignty of
the country. Besides, it also goes against the basic ethos of India's corporate legal regime which is based
on transparency, accountability, fair play and true disclosure. The recent crackdown against shell
companies is a welcome step in right direction and it will go a long way in boosting the investors'
confidence in India's Financial Institutions and strengthening the transparency norms in India's
corporate legal system.

■■

1. FATF is an inter-governmental body that sets up minimum standard for anti- money
laundering legislations for its members. It was set up in the year 1989.
2. Section 248 of the Companies Act, 2013 provides that where Registrar has reasonable cause to
believe that a) a company has failed to commence its business within one year of its
incorporation or b) a company is not carrying on any business or operation for period of two
immediately preceding financial years and has not made any application within such period
for obtaining the status of a dormant company under Section 455, he shall send notice to the
company and all the directors of the company, of his intention to remove the name of the
company from the registrar of companies.
3. The OECD has defined shell company as a firm that is formally registered, incorporated or
otherwise legally organised in an economy but which does not conduct any operations in that
economy other than in a pass-through capacity.

about:blank 6/6